As health care expenses continue to rise, consumers are taking on a bigger role in paying and managing health care costs. This increase in consumer responsibility ranges from greater cost-sharing for medical services to having to choose among increasing health care financing options. One important tool for consumer participation in health care is the use of consumer-directed accounts. Consumer-directed accounts are dedicated funding pools used for health care expenses at the discretion of an individual. These accounts can be procured either individually or through an employer, and may or may not involve tax advantages to the user of the account. A key requirement in the use of consumer-directed accounts is that they finance only those goods and services that are authorized by the Internal Revenue Service (IRS) as eligible medical expenses. This creates the need for close oversight of consumer-directed account programs, which involves high paper volumes, manual intervention, and substantial administrative expense to ensure compliance. In addition, the current process often requires participants to pay for goods and services and then file for reimbursement out of the funds contributed to the consumer-directed account. This requires participants to make the payment up-front even though the funds may have already been set aside and to handle a variety of paper documents during filing and reimbursement. These challenges significantly undermine the efficiency of consumer-directed account programs, resulting in dissatisfied participants and program sponsors. Given these difficulties, there is a clear need for an electronic solution that automates the administration and use of consumer-directed accounts, while maintaining compliance with the rules and regulations under which consumer-directed accounts are governed.
The trend to consumer-directed health care has been supported by three major legislative innovations within the past thirty years; namely, the Revenue Act of 1978, the Health Insurance Portability and Accountability Act of 1996 (HIPAA) and a ruling in 2002 by the IRS establishing Health Reimbursement Arrangements. Each of these initiatives created the model for a consumer-directed account in use today. The Revenue Act of 1978 created Flexible Spending Accounts (FSA), which are employer-sponsored accounts funded by employees' pre-tax contributions from payroll. Flexible Spending Accounts can be established and used for a variety of purposes, such as the payment of health care, dependent care, or public transportation expenses. Because Flexible Spending Accounts are funded with pre-tax dollars, participants in an FSA program can realize substantial savings on eligible expenses. Employers value FSA programs because these accounts provide benefits to employees and reduce employees' taxable income on which an employer must pay Federal Insurance Contributions Act (FICA) taxes. Currently, there are more than 8 million Health Flexible Spending Accounts in the US, with over 9 billion dollars in annual contributions. Health FSA contributions are expected to grow significantly over the next several years, as consumers take on more of the burden for health care costs and seek tax-advantaged tools to finance those expenses.
Two other types of consumer-directed accounts—the Medical Savings Account (MSA) and the Health Reimbursement Arrangement (HRA)—were introduced within the past decade. The MSA was established with the passage of HIPAA in 1996. The MSA provides for a tax-advantaged account reserved for individuals who are self-employed or employed at a small business, and who use a qualifying high-deductible health plan. The MSA is designed to provide tax benefits on payments towards a deductible portion of a high-deductible health plan. A key advantage of the MSA to participants is the ability to carry over unused funds in the account from one plan year to the next. This differs from FSA programs that require unused funds to be forfeited by the employee and turned over to the employer health plan, a requirement commonly known as the FSA “use it or lose it” provision. The IRS established the HRA in June 2002, drawing on the strengths of both the FSA and the MSA. For example, employers of all sizes may implement an HRA program (e.g., FSA). In addition, unused funds contributed to an HRA may roll over from one plan year to the next, like MSA. Due to its flexibility and attractiveness to employees, the HRA is expected to quickly become prevalent throughout the employee benefits marketplace.
A result of these initiatives is the proliferation of consumer-directed accounts used to provide tax advantages for health care spending. Although FSA, MSA, and HRA are the most common forms of consumer-directed accounts, others may also exist. As consumer-directed health care evolves, there will be continued innovation in the field of consumer-directed accounts. This will likely result in new account structures being introduced over time.
Because consumer-directed accounts are legal structures, there are a wide variety of associated rules and regulations. Some important rules include provisions on the types of expenses that can be financed through a consumer-directed account, as determined by the IRS. In general, consumer-directed accounts can only pay for expenses that are medically necessary (such as prescription eye care, prescription drugs, hearing devices, or any other medically necessary expenses), whereas expenses that are not medically necessary (typically “cosmetic” goods and services such as non-prescription sunglasses, cosmetic surgery, or any other non-medically necessary expenses) are deemed ineligible. Because consumer-directed accounts confer tax advantages to participants, the IRS requires strict compliance from employers and their agents to ensure that only eligible medical expenses are financed through a consumer-directed account. If ineligible medical expenses are paid for through a consumer-directed account, tax advantages are being made available inappropriately. As a result, the IRS can assign and enforce penalties for non-compliance.
Most consumer-directed accounts offered through an employer benefits plan are managed and administered by an entity other than the employer itself, usually a Third Party Administrator (TPA). A TPA can provide a variety of services to employers, such as managing claim submissions from employees and generating reports on plan usage. The requirements to comply with IRS guidelines for expense eligibility create a heavy burden on the TPA in managing a consumer-directed account program. Whenever an employee files for reimbursement out of a consumer-directed account, the TPA must audit and validate the claim to ensure that it is for a valid medical expense. Typically, the employee will provide proof of eligibility in the form of a paper receipt or invoice documenting the nature of the expense, which the TPA reviews to confirm compliance. This validation process is extremely labor-intensive and generally requires TPA personnel to review a given claim manually. Further complicating the TPA's task of ensuring compliance is the ability of employers to customize expense eligibility rules to their particular program. That is, although the IRS governs what is potentially allowed, employers have the option to limit further the specific types of expenses that their particular consumer-directed account program will authorize. A TPA must therefore consult the plan rules for a given program before granting approval to an employee's claim. After the claim has been deemed eligible and sufficient funds have been confirmed within the employee's consumer-directed account, the TPA will remit funds, usually by paper check, with a paper explanation of payment to the employee.
Because of the challenges associated with the current manual processing and administration of consumer-directed accounts, industry participants have attempted to develop a variety of mechanisms to streamline activities and improve automation. As consumer-directed accounts grow in importance and usage, these efforts will become increasingly relevant to the ways in which health care expenses are paid and managed.
Efforts to innovate within the administration and use of consumer-directed accounts have historically proceeded in two key ways. First, many Third Party Administrators have attempted to manage the existing paper process better without actually reducing the submissions of paper claim forms. An example of this type of innovation is the use of scanning and character-recognition technology to store an electronic copy of paper claims as they are received and to adjudicate claims based on the information contained in the electronic image. Using this type of technology reduces the amount of paper that a TPA has to keep on file and enables better management of claim documents than if such documents were to remain in paper form. Although this approach may realize certain cost savings, the key problems associated with the current process for managing consumer-directed accounts still remain. That is, participants still have to prepare and file paper claims and front payment for goods and services, and Third Party Administrators must still handle paper documents and manually review the expense eligibility of submitted claims.
The second way industry participants have sought to improve the administration and use of consumer-directed accounts is to attempt to reduce the number of paper claim forms submitted by participants. Manual mechanisms for obviating claim form submission have existed for several years. For example, in some cases, a TPA may be able to make a direct payment from a consumer-directed account to a provider of eligible goods or services without the participant having to file a claim form or initiate a payment. This method is usually applied for payments that are recurring in nature (such as elder care or regular prescription drug purchases), because it requires notifying the provider to change their process and forward an invoice for payment to the TPA directly rather than to the employee. In addition, such payments are only possible when payment is not required at the time services are rendered. For prescription drug transactions within a pharmacy, for example, payment is expected at the point of sale, precluding a post-hoc payment from the TPA to the provider. Moreover, although the participant does not have to file a paper claim form, the TPA must still employ a manual process for adjudicating and paying claims.
Another manual mechanism for reducing the number of paper claim submissions by savings account participants is to automatically apply consumer-directed account funds towards deductibles or co-payments determined under an employer-sponsored health plan. This option has historically been possible only when the TPA manages claims for both the consumer-directed account and the health plan for a given employer. In this scenario, an employee obtains goods or services from a medical provider, causing the provider to generate and submit a claim to the employee's health plan. Once the TPA has adjudicated the claim and determined the employee's payment responsibility, the TPA remits funds from the consumer-directed account directly to the provider, eliminating the need for the employee to pay the provider up-front and then prepare and file a claim with the TPA for reimbursement from the consumer-directed account. However, instances when an individual TPA manages both the consumer-directed accounts and the health plan for a given employer are limited, making this option available to relatively few consumer-directed account participants.
An alternative mechanism for reducing paper claims submissions and improving efficiencies involves enabling electronic claim submission and payment through the use of a stored value program. A stored value program typically includes supplying each participant with a payment card that is linked to a consumer-directed account. A participant then presents the physical card or the card number for payment wherever medical expenses are incurred. The health care provider initiates a payment transaction, that transfers funds from the consumer-directed account to the provider's bank account, eliminating the need for the participant to provide up-front payment and then file for later reimbursement through the TPA. Likewise, the TPA benefits by not having to manage and process paper forms and claims associated with the card-initiated transaction. Because of the wide acceptance of payment cards, participants are able to use consumer-directed account funds in a variety of venues, such as in a retail location, through the mail, or over the phone and other types of transactions.
In stored value arrangements, payments are made directly from the FSA without being substantiated first as eligible expenses. This forces the TPA to solicit receipts from the employee and make restitution to the FSA for non-compliant claims. Often, the employee is lax with submission and sometimes may fail to submit receipts at all.
Although stored value programs have the potential to create substantial efficiencies and benefits, they also have the potential for substantial abuse. In particular, current programs risk exposing employers and Third Party Administrators to non-compliance with IRS guidelines for consumer-directed account expense eligibility. Unlike the current manual process that allows a TPA to audit detailed transaction information in the form of a submitted receipt, card transactions generally communicate only the payment amount requested and the type of merchant that is initiating the transaction (e.g., a pharmacy, a toy store, etc.). Many stored value programs thus authorize the use of card payments to merchants that are considered “health care providers” (such as doctors, optometrists, pharmacies, etc.) and deny card transactions at non-health care merchants (such as a toy store or apparel retailer). This type of filtering is inadequate because many putative health care merchants may still sell goods or services that do not meet the IRS guidelines for payment from a consumer-directed account. For example, a consumer-directed account participant receiving services from a physician's office may be receiving cosmetic enhancements that are not medically necessary. Alternatively, a participant may present their card at a pharmacy for payment toward a wide variety of non-eligible goods (e.g., magazines, office supplies, etc.). Unless a stored value program analyzes detailed, individual transaction data to determine expense eligibility, ineligible expenses may be inappropriately authorized and funded by the consumer-directed account.
Because of the risk of non-compliance associated with card programs, many Third Party Administrators review card transactions post-payment and audit them for inappropriate activity. According to IRS guidelines, claims do not need to be confirmed as eligible expenses prior to payment as long as 100% of all claims are reviewed post-payment. In cases where expenses paid by a consumer-directed account are later deemed ineligible, participants must be made to restore misappropriated funds to the savings account, forcing the TPA into the costly and awkward role of collections officer. Due to the risk of fraudulent payment, a TPA may even require that a participant substantiate every card transaction with paper documentation, which then fails to relieve employees and Third-Party Administrators of the traditional challenges associated with participating in and managing a consumer-directed account. Frequent TPA audits and collection activities can significantly undermine the efficiencies that stored value programs were designed to achieve.
Because the IRS has the ability to levy substantial fines for non-compliance, many employers are unwilling to accept the risks associated with current stored value programs, opting instead for the less efficient but potentially more compliant traditional, manual process.